4 Simple Lessons on Cost, Price, Margins

Netflix Case Study

Netflix made a subtle change to their website in December of 2009. The “Watch Instantly” option was moved to the first position on its row of website navigation tabs. The DVD rental company has always been about convenience, but this change from sending discs in the mail to streaming video over the Internet is no small deal.

Netflix ships 2.2 million DVDs every day and the round trip ticket for each of those discs costs 84 cents. Netflix will spend close to $600 million this year in getting discs to their customers. That gives the movie rental company a pretty big incentive to pursue alternatives delivery methods.

The cost to stream the same gigabyte of Hollywood magic over the Internet: 5 CENTS.

If Netflix can convert 10% of their volume from postal to digital, $60 million falls to the bottom line.” – Fixed to Flexible EBook

Value investing involves understanding the business. I’m sure most NFLX investors understand the business as summarized in Google Finance and the annual reports, but how many people actually spent time analyzing the website which is a huge factor for the company? This is also something that would never come up in any conference call.

After reading this one paragraph, my view of NFLX has radically changed. I was in agreement with this article from seekingalpha, but now I see how wrong it is. I sure wouldn’t want to be shorting NFLX now.

Interpreting a Business with Insight

Such simple things can make quite a difference with businesses. I’ve come across similar “what if” examples due to my interest in design, usability and marketing.

E.g. Take a look at Zappos.com, an online retailer for shoes, bought out by Amazon. This designer created a mock up version of a spruced up, much easier to view Zappos website which I’m sure will certainly help convert visitors into customers at a higher rate, which means more profit. The interesting thing is that the Zappos website has actually changed since then.

What would happen if airlines redesigned their totally crap  boarding passes? Creating an aesthetic look will not only help direct travelers, but it could build brand awareness.

Think beyond the barrier and imagine what the top line could produce if airlines starting printing simple text Google Adwords type ads on their boarding pass. This is just a “what if” example but one which wouldn’t make it to the annual report or quarterly conference calls. This is why Buffett, Munger, Peter Lynch were so successful. Their business insight and hands on experience is amazing.

You’ve heard the cliche that valuation is more art than science. The above examples are prime examples of art.

Valuation is an Art

Numbers, accounting and financial statements can only tell you so much, but it’s being able to interpret, understand and having insight to a business that is extremely valuable in any stock analysis.

Take the time to read the following ebook. It’s an amazing primer to get you started in thinking about costs, prices, margins and how it affects businesses.



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7 responses to “4 Simple Lessons on Cost, Price, Margins”

  1. I have Netflix service and I do not remember when was last time I had them mail me a DVD disk.

    Still have their last DVD disk, but the envelope is gone so the disk sits on my desk for the past couple of months.

    We have switched to instant watch completely.

  2. Ankit Gupta says:

    I had looked at Netflix a while ago and I think the question I came to was how much it costs them to get rights to stream the movie each time. I was under the impression that it cost them more than the cost to physically mail the DVD, and so it’s actually a lower margin service.

  3. Jae Jun says:

    @ Ankit,

    Considering they are delivering content and probably have distribution rights, I don’t see how streaming would be a lower margin service. Costs for shipping the DVD’s will include postage (send + receive), envelope, sorting through inventory, manual labor.

    Streaming would cut out bunch of bottlenecks and costs.

  4. Jae – Just wanted to say thank you reading Fixed to Flexible and for posting the ebook here.
    .-= Todd Sattersten´s last blog ..Fixed to Flexible Interview with Evernote CEO Phil Libin =-.

  5. Jae Jun says:

    Thanks for writing such a great ebook. I read it from Seth Godin’s blog btw.

  6. edward says:

    Is NFLX the obvious winner 10yrs from now? I know i can’t say and would be suprised if anyone else could. Too many varibles.

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